A federal judge says Stockton, Calif., may continue with its bankruptcy filing. The judge ruled Monday that the city does not have to take money from its pension obligations to pay its debts.

STEVE INSKEEP, HOST:

A federal judge has ruled that Stockton, California, may enter into bankruptcy proceedings. That opens the way for Stockton to become America's largest bankrupt city. The population there is 300,000, bigger than Cincinnati, Newark, New Jersey or St. Paul, Minnesota. NPR's Richard Gonzalez reports that others cities share Stockton's problems.

RICHARD GONZALEZ, BYLINE: When the housing market tanked, Stockton, 90 miles east of San Francisco, had one of the highest foreclosure rates in the country. Revenues based on developer's fees and property taxes dried up over night. Basic services like police and firefighters were slashed. Then the city filed for bankruptcy in June of last year. But the Wall Street firms that backed the city's bonds to the tune of more than $160 million feared they would only be repaid cents on the dollar.

So after some talks, they challenged Stockton's bankruptcy petition, arguing that the city could have raised taxes and more importantly cut pension payments to raise more money. On Monday, U.S. bankruptcy Judge Christopher Klein dismissed the creditors arguments. Karol Denniston is a municipal bankruptcy expert who is monitoring the trial.

KAROL DENNISTON: That's pretty important because the court didn't accept any of the arguments from the capital markets creditors, and in fact, found on the record that the capital markets creditors had not negotiated in good faith.

GONZALEZ: Now Stockton must win the judge's approval for its plan to restructure its debt. A large part of that debt, about $900 million, is owed to the California Public Employees Retirement System or CALPERS. Michael Sweet, a municipal bankruptcy attorney, says the Stockton case has broad national implications because many cities are running into trouble with their pensions.

MICHAEL SWEET: And this is a big issue, not just in Stockton, but in San Bernardino, which filed bankruptcy in southern California a couple of weeks after Stockton, and it's a big deal in other places like Detroit where everyone is watching to see what this judge says about how the federal bankruptcy law addresses a city pension obligation.

GONZALEZ: Sweet and other legal observers say they don't expect the Wall Street firms to give up this fight any time soon and they will aggressively challenge Stockton's plans to repay the state pension system. Richard Gonazalez, NPR News.

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